RBA Joins the Other Clowns

Yesterday, Reserve Bank of Australia Governor Philip Lowe delivered a speech in Sydney.

It was all very ‘sensible’. And boring. Central bankers’ speeches usually are.

In fact, they are usually so boring I cannot bring myself to read them, let alone take up your precious time telling you about them.

But in this case, it’s important. It has big implications for the economy and markets over the next few years.

Before I get into that detail, let me share some interesting tidbits that came out of the speech. Firstly, housing bears will be disappointed to learn that household balance sheets actually strengthened during the pandemic.

For many people with a mortgage, much of the extra savings and some of the superannuation withdrawals have been used to increase their balances in their offset accounts, with offset balances up 10 per cent since March. Other people have simply paid down principal directly. Combined, all forms of mortgage payments — including the additional balances in offset accounts — reached a record high over recent months, despite repayments being deferred on around 8 per cent of housing loans.

You can see this increased flow into paying down mortgages via increased principle and offset account balances, in the chart below.

Port Phillip Publishing

Source: ABS, APRA, RBA

[Click to open in a new window]

This household balance sheet deleveraging though was more than offset by the federal government’s fiscal stimulus.

After all, in a debt-based financial system, any deleveraging will not be accepted. When the private sector pulls its head in, the government opens its magic wallet (which is really funded by the private sector) and spends.

The RBA’s attempt to promote confidence

And, as Mr Lowe pointed out, the federal government has the capacity to spend a lot.

The national balance sheet is in a strong position and is able to provide the support that is now required. The Australian Government can borrow at the lowest rates ever and the demand from investors for government bonds remains very strong. The states and territories can also borrow at record low rates and have an important role to play in the national fiscal response.

So, at this point, I’m thinking we’re in pretty good shape. The household sector has been conservative and improved its balance sheet somewhat. I mean, at least the cratering economy didn’t make it worse.

But then Mr Lowe turns to monetary policy and now I’m not so sure.

The Board will not be increasing the cash rate until actual inflation is sustainably within the target range. [2-3%] It is not enough for inflation to be forecast to be in the target range. While inflation can move up and down for a range of temporary reasons, achieving inflation consistent with the target is likely to require a return to a tight labour market. On our current outlook for the economy – which we will update in early November – this is still some years away. So we do not expect to be increasing the cash rate for at least three years.

This is the RBA’s attempt to set expectations and promote confidence.

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I don’t know about you, but when you tell people that rates aren’t going anywhere for a long time, they know that’s not a good thing.

Rates rise in a healthy economy, and they decline and stay low in a bad one. So thanks, Mr Lowe, for confirming the Aussie economy is in a hole that it won’t get out from for a long time.

The RBA appears to be under the same impression that the Bank of Japan, the ECB and the US Fed are…that they can create inflation and goods and services prices.

10 years of post-GFC ‘money printing’ should tell you that’s nonsense. Make it 30 years for Japan.

But like the other clowns in their ivory towers, where their actions have no personal consequences, it won’t stop them from trying. Mr Lowe hinted that another rate cut is coming soon.

As the economy opens up, though, it is reasonable to expect that further monetary easing would get more traction than was the case earlier.

More worryingly though, he hinted at what might be coming in 2021, Quantitative Easing (QE), or balance sheet expansion.

A third issue is what is happening internationally with monetary policy. Australia is a mid-sized open economy in an interconnected world, so what happens abroad has an impact here on both our exchange rate and our yield curve. In the past, the interest differentials provided a reasonable gauge to the relative stance of monetary policy across countries. Today, things are not so straightforward, with monetary policy also working through balance sheet expansion. As I noted earlier, our balance sheet has increased considerably since March, but larger increases have occurred in other countries. We are considering the implications of this as we work through our own options.

In other words, if everyone else is doing it, we might need to as well.

Instead of looking at the horrendous outcomes of QE around the world and resisting the urge to follow, it looks like we’re following the lemmings over a cliff.

This will make the economy even worse. That’s why bond yields are falling again to their lowest point since the panic caused by the economic shutdowns in March and April.

Secular decline is what it is. Sure, fiscal stimulus will provide short-term growth bursts, but when it washes through, we’re back to crying out for more.

That’s what the bond market is telling you.

And the stock market?

It will love the twin hits from fiscal stimulus and another expected rate cute. And it will take disinflation over inflation (rising bond yields and discount rates) any day of the week.

But don’t mistake a bullish market for a bullish economy.


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Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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